Key’s Surplus Pledge Shows Restraint Outweighs Europe Risks

May 22 (Bloomberg) -- New Zealand Prime Minister John Key
said his budget this week will show the government returning to
a “small” surplus in 2015, signaling fiscal restraint even as
Europe’s debt turmoil and a global slowdown threaten growth.

Key, 50, is insisting new health and education spending be
funded by savings elsewhere as the country seeks to end six
years of deficits and limit public debt. Spending restraint
makes it harder for growth to accelerate 15 months after the
deadliest earthquake in eight decades, adding pressure on the
central bank to keep interest rates near a record low for longer
or reduce them further.

New Zealand’s 10-year bond yield fell to a record last week
and its currency is down 6.4 percent this month as investors
increased bets the Reserve Bank will cut interest rates as
commodity prices fall, curbing exports which make up 30 percent
of the $127 billion economy. Standard & Poor’s, which lowered
the nation’s foreign-currency debt rating to AA in September,
wants the government to stay on a surplus path without stalling
a sluggish recovery.

“Against the backdrop of Europe, we’re saying that
governments intent on returning their budgets to surplus are
still a good thing but they should be doing it as conditions
allow,” Kyran Curry, an S&P analyst in Melbourne, said in an
interview. “It doesn’t matter so much to us if the New Zealand
government delays its surplus one or perhaps two years, but we
are saying that can’t go on for an extended period.”

Surplus Target

The deficit will narrow to NZ$12.1 billion ($9.2 billion)
in the fiscal year ending June 30 from a record NZ$18.4 billion
a year earlier, the government projected in February. It
forecast a NZ$370 million surplus by June 30, 2015.

In a press conference yesterday, Key said that while his
fiscal policy remains flexible, a projected euro-area recession
doesn’t appear to be deep enough yet to warrant extending New
Zealand’s series of deficits.

“The last thing we want to do is to abandon that target
unless we really have to,” Key said before presenting his
budget May 24.

New Zealand’s shortfall is expected to be 5.8 percent of
gross domestic product in 2012-13, government projections show.
That’s wider than the more than 8 percent gaps in the U.S. and
U.K., according to data compiled by Bloomberg, and 3 percent
deficit in Australia, which this month pledged a return to
surplus by June 30 next year.

Falling Currency

The New Zealand dollar is the worst performer this month
among the Group of 10 currencies tracked by Bloomberg. The so-called kiwi is down about 13 percent since it reached 88.43 U.S.
cents on Aug. 1, the strongest since it was freely floated in
1985.

The country’s sovereign bonds have handed international
investors an 8.1 percent return over the past 12 months. When
adjusted for currency movements, they are the fourth-best
performer among 26 indexes tracked by Bloomberg and the European
Federation of Financial Analyst Societies.

Key, a former foreign-exchange head at Merrill Lynch & Co.,
was re-elected in November to a second three-year term. He has
said he will raise tobacco taxes and prescription charges, and
review property taxes in the budget. The government will also
require students to repay loans faster and ensure a limit on
student allowances is enforced.

Government spending accounts for about one-fifth of New
Zealand’s GDP.

‘Sub-par Growth’

“Greater fiscal retrenchment reinforces our expectation of
a sub-par growth performance,” said Philip Borkin, economist at
Goldman Sachs New Zealand Ltd. in Auckland. “It is also
consistent with little pressure on the Reserve Bank to act in
the near term and a modest tightening cycle by historical
standards when it does begin.”

The Pacific nation’s economy is also driven by demand
overseas for its raw materials including milk powder, lumber and
wool.

Commodity export prices dropped the most in more than three
years in May to an 18-month low. Fonterra Cooperative Group
Ltd., the world’s biggest dairy exporter, today cut its forecast
milk payment to farmer suppliers for the year ending May 31 by
4.7 percent and said next year’s payout may be 9.1 percent lower
again because of falling global prices.

Weaker commodity prices are a reason there is a 55 percent
chance of a quarter percentage-point rate cut from a record-low
2.5 percent at the central bank’s next meeting on June 14,
according to interest-rate swaps data compiled by Bloomberg as
of 11:40 a.m. in Wellington. There is an 83 percent chance of a
reduction by September.

Rebuilding

Borkin forecasts New Zealand’s economy will grow 1.7
percent this year after expanding 1.1 percent in 2011. Growth
will accelerate to 3.4 percent in 2013 led by construction in
Christchurch, where last year’s temblor killed 185 people and
led to the demolition of more than 1,000 central city buildings.

Insurance costs and spending on quake assistance
contributed to a record budget deficit last fiscal year, while
net debt is projected to rise to 29.6 percent of GDP by 2015.

The government last year said it will sell no more than 49
percent in four state-owned energy companies and also reduce its
stake in Air New Zealand Ltd. An initial public offering of
Mighty River Power Ltd. is expected in the third quarter.